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Surge in free cash flow may fizzle out Print E-mail
Tuesday, 08 September 2009

By Ronald Fink

Corporate free cash flow rose substantially during the second quarter of the year, according to a study of 3,518 companies by the Georgia Tech Financial Analysis Lab. But the study, based on results for non-financial U.S. companies with a market capitalization of at last $50 million, also found that the improvement was driven largely by reductions in capital spending and working capital, suggesting that the improvement in cash flow may not be sustainable.

For the twelve months ended June, 2009, the study found that the companies' average free cash margin, that is, the percent of revenue generated as free cash flow (or cash flow available for shareholders after all prior claims, including interest, taxes and capital expenditures, have been covered), improved to 4.8 percent, up from the recession low of 4.1 percent reached in December 2008 and from 4.6 percent for the twelve months ended March 2009.

The improvements noted in the first quarter of 2009 continued into June, suggesting the much-discussed turnaround in the U. S. economy remained on track. By comparison, the index reached 2.4 percent in March 2001, the low point in the last recession.

However, free cash margin for the most recent quarter improved even though profitability, as measured by operating cushion (or operating profit minus non-cash expenses for depreciation and amortization), declined slightly. That indicates that the improvement in free cash margin was driven by sizable reductions in both capital spending and the cash cycle. Income taxes paid as a percentage of revenue also declined.

The report released on Friday noted that the continued improvement in free cash margin is a positive development and consistent with the improvements noted in share prices since early March. But it also said that the long-term viability of the recovery will require a return to improving profitability.

"Confirmation of the end of the recession on a cash flow basis will require an improving free cash margin driven more by improving profitability, as evidenced by improving operating cushion, and less through reductions in capital spending and the cash cycle," the study noted. Its authors were Charles Mulford, an accounting professor at Georgia Tech who directs the lab and serves on CFOZone's editorial advisory board, and research assistants Andrew Parkhurst and Brandon Miller.

"If operating profitability does not turn up," the authors concluded, "the expectation is that free cash margin will likely decline again."

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Mary Driscoll
written by Mary Driscoll, September 14, 2009
Professor Mulford and his colleague are firing a shot across the bow here! And CFOs ought to take heed--you will find resistence the next time you need to tap banks or capital markets for loan financing or re-financing if the ONLY thing you've done to work on your cash flow profile is to cut capital spending and eliminate jobs. Smart CFOs have been taking the opportunity to investigate and repair the root snags that keep cash trapped in working capital. Sadly, however, I'd say that this is an area that remains ripe for repair for many large companies. Looking at our APQC benchmarks in the area of "cycle time to approve an invoice for payment" or, alternatively, "issue a clean invoice," one immediately sees shocking gaps between the good, the bad, and the ugly. Some unpleasant net effects for companies with spare cash: forget about grabbing that 2%/10 days early pay discount if you can't approve an invoice faster than 15 days, which is the case at a a surprising number of companies. On the A/R side, the best-practice firms can generate an accurate invoice 3 times faster than the laggards. IF DSO-creep is your enemy, you cannot afford to be slow in getting clean invoices out the door. Worse, perhaps, 50% of CFOs we surveyed said their teams fall down on the job when it comes to forecastign near-term cash collections.
What gives? Truth be told, repairing working capital management is easy to ignore
for two reasons: 1) it's a dark "back office tangle of wires and processes" that senior management just cannot get excited over, never mind spend money to fix (2)true success requires tremedous cross-function collaboration... read: politcal nightmare.
Please visit for a look at some of our recent survey findings around working capital management
-- Mary Driscoll: This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

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